ARTICLE
19 March 2020

Delhi High Court Has Held That Criminal Proceedings U/S 138 Of Negotiable Instruments Act, 1881 Is Not Maintainable Against Non-Executive Directors Of A Company

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The summons order was challenged before the Delhi High Court.
India Corporate/Commercial Law
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Recently, the High Court of Delhi in Sunita Patla & Ors vs M/s Kit Marketing Ltd1 has held that under section 138 of the Negotiable Instruments Act, 1881 ("Act") which pertains to the dishonour of cheque and which attracts criminal liability, the Court held that non-executive/independent directors of a company who are not involved in day to day to affairs of the company would be exempted from this liability.

Facts of the Case: petitioners (Sunita Patla & Ors) in the present case were summoned for the offence punishable under Section 138 of the Act.

Respondent (M/s Kit Marketing Ltd) had filed a complaint stating that the accused were regular purchasers of goods from the complainant (M/s Kit Marketing Ltd) on a credit basis and made regular payment towards sale consideration from time to time in the past. There was an outstanding balance payable by the accused against which four account payee cheques were issued. However, the same were returned unpaid to the complainant vide bank's return with remarks "Funds Insufficient".

Complainant (M/s Kit Marketing Ltd) issued a legal notice of demand calling upon the accused to make payment within fifteen days from the date of receipt. Since no payment was made within the statutory period of fifteen days, a complaint under Section 138 read with Sections 141/142 of the Act was filed. Accordingly, the present petitioners (Sunita Patla & Ors) being non-executive directors were summoned for the offence punishable under section 138 of the Act. The summons order was challenged before the Delhi High Court.

The limited issue raised in this case was, whether the non-executive directors of a company are liable for cheque dishonour proceedings under Section 138 of the Act or not?

Broad submissions made by Sunita Patla & Ors (petitioners in the said case)

Sunita Patla & Ors contented that, they were the non-executive/additional directors and were never involved in the day to day affairs of the company at any point of time. Admittedly, they were neither, the managing directors, nor the signatories to the cheques in question. To buttress this argument, they also showed the Court the annual reports of the company which showed the petitioners as non-executive/independent directors.

The above judgement amongst other judicial pronouncements reiterated the earlier principles laid down in the Apex's Courts judgement in Pooja Ravinder Devidasani vs State of Maharashtra and Anr2 which had dealt with the issue of vicarious liability, qua such non-executive directors and had held as follows: -

"A non-executive director is a custodian of the governance of the company, but is not involved in the day-today affairs of the running of its business and only monitors the executive activity. To fasten vicarious liability under Section 141 of the Negotiable Act,1881 on a person, at the material time that person shall have been at the helm of affairs of the company, one who actively looks after the day-to-day activities of the company and particularly responsible for the conduct of its business. Simply because a person is a director of a company, does not make him liable under the Act. Every person connected with the company will not fall into the ambit of the provision".

The Delhi High Court in its judgement also referred to the Apex Court's judgement in Chintalapati Srinivasa Raju vs Securities and Exchange Board of India3, wherein the Apex Court had held that non-executive directors are persons who are not involved in the day to day affairs of the running of the company and are not in charge of and not responsible for the conduct of the business of the company.

The Court after perusing the complaint and after following the Apex's Courts precedents as referred above on non-executive directors held that since, save and except for the general allegations against Sunita Patla & Ors, no specific role of handling the day to day affair were attributed to them, the Court quashed the summons issued to them.

To sum it up it is no doubt, that the directors stand in a fiduciary position with the company and are expected to manage the affairs of the company in a manner beneficial to the interest of the company and its stakeholders. Director's liability arises because of their position as agents or officers of the company as also for being in the position of trustees or having fiduciary relation with the Company or its shareholders. To fasten the criminal liability under the Act on non-executive directors/independent directors a complaint should have specific details and role of such directors should be explained rather than bald assertions so as to fasten liability on them under the Act.

On another note it is also apposite to mention that a day prior to passing of the above Delhi High Court's Judgment, the Ministry of Corporate Affairs ("MCA") vide their circular dated March 2, 20204 ("Circular") had issued certain Standard Operating Procedure to all Registrar of Companies, Regional Directors and the Official Liquidators with respect to prosecutions, or internal adjudication proceedings for offences under the Companies Act, 2013 ("2013 Act") against independent directors, non-promoters, non-KMP (key managerial personnel) and non-executive directors.

Key takeaways from the above Circular are:

Nature of default shall be critically examined before prosecuting officers of the company for defaults committed under the 2013 Act;

Registrar may seek necessary documents at the time of serving notices to the company as to ascertain the involvement of the concerned officers of the company, all care must be ascertained to ensure that no unnecessary proceeding has been initiated against non-executive directors, or independent directors;

All records available with MCA including e-forms DIR-11 or DIR-12 shall be crucially examined so as to ensure that whether, the particular director, or KMP was associated with the company as on the date of default;

In case of any doubts, with regards to the liability of any person regarding any proceeding, the Registrar may seek guidance from MCA through the office of Director General of Corporate Affairs and

With respect to on- going cases where prosecution may have been already filed, but the above-mentioned criteria is not satisfied, the same may be submitted to MCA for necessary examination and further directions.

Footnotes

1 CRL. MC. 1410/2018- Delhi High Court

2 2014(14) SCALE

3 2018 7 SCC 443

4 Circular No 01/2020 issued by Ministry of Corporate Affairs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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